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4 Tips for Your Tax Refund

Got money coming? Don't spend it on the wrong stuff.

No matter how often some personal finance "expert" says that getting a tax refund amounts to giving the government a free loan, taxpayers still love finding those big checks in the mail after they file. But with times as tough as they are, you can't afford to waste that money.

In brighter times, many people used their tax refund checks as a slush fund for a big purchase, such as a car or nice vacation. This year, though, consider doing something with your refund money that will give you a lot more than memories of lost luggage or your local repair shop.

1. Fund an IRAOK, so saving money for retirement doesn't have the same appeal as the Caribbean. But if you want to set things up to spend years of your life traveling in the future, there's a small price to pay: You have to plan.

Getting money into an IRA can be the first step toward ensuring a wonderful and financially secure retirement. With your choice of a current tax deduction from a traditional IRA or tax-free growth in a Roth, you can pick how best to get started.

Moreover, by investing in an IRA rather than in a regular account, you'll save money year after year. Consider the tax savings from investing in a sample of stocks:

And if that doesn't seem like a lot, consider: That's how much you save from each $5,000 you invest, and you save it every year between now and when you retire. Over time, that really adds up.

2. Give it awayWith times as tough as they are, many people haven't been able to give as much to charity as they'd like. A windfall like a tax refund could let you remedy that.

Some charities are specifically looking for contributions from tax refunds. Heifer International, for example, has chosen April to run its Pass On The Gift campaign, hoping to find donors who'll pay some of their IRS bounty toward a worthy cause. Other charities run similar campaigns. And while those gifts won't save you on today's tax bill, they will give you a valuable deduction you can use on your 2009 taxes.

3. Pay down debtFor most people, the best investment is getting rid of bad debt. With credit card rates on the rise, anyone with outstanding balances on cards will want to pay them down as quickly as possible.

A tax refund can go a long way toward helping on that score. If you have a 15% interest rate, using a $2,000 tax refund to pay down credit card debt not only gets you closer to a debt-free balance sheet, but also saves you $300 per year in interest. That's a reward you can't afford to pass up.

4. Find a fundUnless you paid a whole lot more than you should have, your refund may not go a long way. But you can still get your money to work in the market with the diversification of mutual funds.

With just a small amount, a fund can give you exposure to hundreds of companies. For instance, the Fairholme Fund (FAIRX) has invested in winners like Canadian Natural Resources(NYSE:CNQ) and Humana(NYSE:HUM), and currently is betting big that pharma giant Pfizer(NYSE:PFE) will recover from extensive losses over the past decade. And while Fairholme's minimum investment is $2,500, other funds have minimums as low as $100.

Don't blow itBefore you use your tax refund for some extravagant purchase, think twice. By diverting that money to a better cause, you can get a big payback for years to come.

For tips on IRAs, funds, and making ends meet, check out ourRule Your Retirementnewsletter. You can get full access to current and past issues and plenty of other helpful resources free with a 30-day trial.

Frustrated with your 401(k)? Even if your employer's plan isn't the greatest, you don't have to give up your dreams of a happy retirement. Get the tips you need to turn your retirement savings around in our special report, "How to Make the Most of Your 401(k)" -- just click here for instant free access.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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